Extended Essay Economics

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Introduction

IB Extended Essay - Economics Word Count: About 3,690 Abstract Economists have debated the advantages and disadvantages of different exchange rate regimes. An exchange rate regime is how a country chooses to manage the value of its currency with respect to other countries. In the world today, most countries choose to employ a floating exchange rate. Some of the key currencies in the world today such as the dollar, the British pound and the Euro are all floating currencies. In a floating exchange rate, the value of a country's currency fluctuates as demand and supply for said currency changes. Venezuela is among the few countries that employs a fixed exchange rate. The Venezuelan Bolivar is pegged to the US dollar at 2.15 Bs (Bolivares) to 1 $US. This investigation will look at the fixed exchange rate policy in Venezuela and it's affect on the functionality of a firm. The firms that will be analyzed are Manpa, a publically-owned Venezuelan paper firm, and a branch of the Indian pharmaceutical company, Dr. Reddy's, operating in Venezuela. I. Introduction It's often been debated which type of exchange rate is better suited for a country's economy. An exchange rate is the price of one currency in terms of another. A country's exchange rate depends on the exchange rate system they have chosen to adopt. Most countries choose to employ a floating exchange rate policy; in this system, the exchange rate is determined by the market forces, and so, it fluctuates due to the changing market conditions. In February of 2003, Venezuelan president Hugo Chavez introduced a new fixed exchange rate policy. The introduction of the fixed exchange rate has led to the creation of a parallel market in Venezuela because the true value of the currency is still fluctuating due to market forces. Officially, 2.15 Venezuelan Bolivares are worth 1 US Dollar. In the black market however, the Bolivar is valued much weaker and thus one can receive far more Bolivares for their US dollars when trading at the parallel rate. ...read more.

Middle

It seems as though the fixed exchange rate and access to CADIVI allow Manpa to gain greater profits. Their ability to convert Bolivares into dollars at the official rate is likely to have been a very significant factor contributing to their supernormal profits. For the pharmaceutical company however, CADIVI provides a series of difficulties to running a business smoothly and profitably. Access to CADIVI is generally permitted to firms producing products deemed "necessary. Firms in the food, healthcare, automotive, spare parts and some other industries are usually granted access to CADIVI." (Khandelwal) If a firm is selling a product that is considered to be a luxury, however, they must exchange money on the black market. Dr. Reddy's produces pharmaceutical goods, and so, it does have CADIVI access. Despite this, the inconveniences caused by the CADIVI process hamper the firm's ability to function. III. Dr. Reddy's, a pharmaceutical company Since the company I spoke to, Dr. Reddy's, is a pharmaceutical company, it, as well most of its competitors, has access to CADIVI. Given that all of the firms in the pharmaceuticals industry have CADIVI access; there isn't a significant advantage over other firms a firm could gain through CADIVI in this type of market. This type of market could be described as an imperfect oligopoly. The market for medicine contains a few large sellers. A key feature of an oligopoly is that entry is difficult. It is made very difficult to enter the market for pharmaceuticals in Venezuela because of the high costs of producing medicines and because of the bureaucracy involved with gaining CADIVI access. This particular market also features differentiated products. Pharmaceuticals range from antibiotics and cold medicine to cancer treatments. It is for this reason that many firms specialize in their product lines. Dr. Reddy's, for example, focuses much of its research and resources on cancer and diabetes treatments. When I spoke with someone from the firm, I asked if the firm charges elevated prices because of the inelastic demand for medicine. ...read more.

Conclusion

Speaking with the medical firm, however, I was told that despite the relatively inelastic demand for medicine, the numerous competitors provide substitutes which prevent a firm from charging prices that are too high. Manpa, it seems, benefits more from CADIVI because there are not as many competitors in the Venezuelan paper industry. Due to the decreased number of competitors, supply is not quite as high and Manpa has more influence when determining prices. In conclusion, a firm cannot be profitable unless it has access to CADIVI. Convenient CADIVI access allows a firm to benefit significantly. However, if a firm is producing a product that isn't completely necessary, their CADIVI access will be denied and their ability to function in Venezuela will be greatly hampered by the fixed exchange rate. In conclusion, the currency exchange process in Venezuela is greatly complicated. CADIVI access may allow a firm to reap greater profits but it may also prevent a firm from functioning to full capacity. A fixed exchange rate usually brings clarity. The rate should always be the same when exchanging currencies. Because of the parallel market, however, none of these benefits seem to apply in Venezuela. The Venezuelan Central Bank, the BCV, should always be buying or selling bonds and adjusting the interest rate to influence supply and demand of the currency in order to maintain the Bolivar at a fixed rate. This, however, is not that case. Venezuela has attempted to bring the parallel rate closer to the official rate but a lack of foreign reserves has made this difficult. For this reason, the fixed exchange rate currently overvalues the Bolivar significantly. This essentially takes away any of the clarity and predictability that a fixed exchange rate is supposed to bring. It was for this reason the pharmaceutical company I spoke to described Venezuela as a "high risk, high returns" location; this is especially the case now with the drastic drop in oil prices. ...read more.

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